A quiet start to the week was to be expected given the extended holiday weekend for much of the world. While US markets were online Monday, the absence of European liquidity took its toll on conviction. The S&P 500 managed its fifth consecutive advance though progress was tepid and volume was the weakest seen since March 18 – notably the day before the FOMC rate decision. With the trading ranks expected to fill out through the next 24 hours, we are starting to see signs of life in expected volatility readings. Short-term (one-week) implied volatility measures for the dollar-based majors are rounding up from last week’s lows. Of course, marking progress from multi-year lows draws a very different picture than just reviving after a short-lived lull. Immediately important this week is whether risk and/or rate speculation regain traction.

Where is the dollar positioned in the scale of interest rate to stimulus speculation? John discusses in today's Strategy Video.

Yen Crosses Run Questioned on Deficit Swell, GPIF Diversification

Two prominent fundamental catalysts strong-armed the yen crosses higher over the past 18 months: a general appetite for yield / return and heavy stimulus vows by Japanese policy authorities. However, now we find that risk appetite is struggling to press new highs and the BoJ has made it clear that there is little desire to upgrade its sizable open-ended stimulus program. Considering that some of these crosses have risen more than 40 percent over that period and yield differentials have hardly budged to balance their traditional fundamental valuations, the situation is looking more and more like a Wile E. Coyote scenario where the market has already run off the cliff and just waiting for gravity to kick in. Repression and complacency, however, are strong factors in today’s markets. Yet, news that Japan suffered a record April trade deficit and the GPIF pension fund plans to diversify away from local government bonds is trying hard to reengage financial physics.

Euro: A Weekend without an Exchange Rate Threat

It was no doubt refreshing to Euro traders to open the new week Monday without a sharp move lower. Recalling the jump lower on the open last week following the weekend commentary made by the ECB President, we were met with remarkably quiet newswires this past break. Perhaps the lack of liquidity stayed policy officials’ hands or maybe they plan on reserving their open warnings of policy changes to fight a rising exchange rate for when the EURUSD is pressuring 1.3900. The market may put this latter tolerance level to the test if the US dollar doesn’t make its own bid at a meaningful rally in the near future. For scheduled event risk, the Eurozone’s docket is one of the few with noteworthy event risk – the region’s consumer confidence survey – but traders may wait for Wednesday PMI or Thursday’s Draghi speech to weigh in.

British Pound: Will Inflation and Rate Expectations Pick Up Last Week’s Rally?

The Dollar wasn’t the only currency to benefit from a rebound in rate expectations this past week. Two-year Gilt yields surged through Thursday back towards the multi-year (0.743 percent) set at the end of March while Breakeven rates – a measure of inflation expectations – moved into position for an important test of a 12-month range of 3.0 percent. The question is whether this swell was a side effective of unusual liquidity conditions or a genuine rebound in speculative appetite. Sterling traders will watch the official open of London trade after the extended holiday weekend to test conviction. For scheduled event risk, the docket is light until Wednesday’s BoE minutes.

Australian Dollar Traders Shouldn’t Expect New Trends Before CPI

Most traders worry about how the market response to major event risk. Fewer appreciate the consistency in the lead up to such catalysts’ release. Tomorrow morning, the first quarter consumer inflation (1Q CPI) report is due in Australia; and a substantial rebound for the Aussie dollar has leveraged traders’ interest. With swaps close to fully pricing in the possibility of the first 25bp rate hike in three years, a lot is riding on this piece of event risk. Should the core reading meet the 3.2 percent forecast, it could reinforce early calls of emerging pressure for removing accommodation. Miss, and two months of gains can fall apart. Yet, uniformly in the lead up, traders opt for ‘wait and see’.

What is the greatest risk to global growth and financial market health moving forward? A significantly slowdown in China. That was the conclusion of a Reuters poll released recently, but it is the same call seen across many different economist, trader, analyst-based surveys conducted recently. China was one of the standout sources of growth amongst the world’s largest economies – not just the ‘developing’ group – through the Great Recession, and is still considered a key source of expansion moving forward. And yet, the pressure is building. Though foreign reserves grew through March (considered a measure of capital inflow) and financing pressure is being kept in check (CDS are below 90 bps and the 7-day Repo rate is at 3 percent, the specter of economic malaise is growing more corporeal in data.

Emerging Markets Ease on Weeks Open but Volume Plays Down Conviction

The absence of a strong ‘risk’ current meant the emerging market benchmarks would pass a sedate session Monday. We had to look no further than the MSCI Emerging Market ETF to see the type of conditions we were dealing with through the opening session. The product posted a 0.6 percent dip, but volume (29.3 million shares) was the lowest since the Christmas period –and before that not since February of last year. Within the FX ranks, most of the moves were modest. The stand out was the Columbian Peso (COP) which rallied 0.6 percent versus the dollar. On the short side, the Indian Rupee fell 0.5 percent, Russian Ruble 0.3 percent and Turkish Lira 0.2 percent against the greenback.

One of the few benchmark assets posting close-to-normal activity levels, gold’s opening move proved an unflattering one. Spot gold closed down 0.4 percent Monday after a feigned attempt to retake $1,300. Though this commodity may not depend on the same level of fundamentals that the standard financial outlets do; the absence of speculative interests along with the preoccupation with stimulus and inflation forecast were working against an errant trend on the metals behalf. As we look ahead to the round of global monetary policy updates for fundamental influence, we should keep in mind speculative appetites as a primary driver. The COT report from the CFTC reported not long speculative futures holdings tumbled a fourth consecutive week through the April 15 period. Cumulative, that is a 42 percent drop in long interest from the one-year high set just this past month.**Bring the economic calendar to your charts with the DailyFX News App.

Existing home sales have contracted significantly since June of 2013. This type of fall in demand may be interpreted as a reduction in inflationary pressures as the economy becomes more self-sustaining.

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